Is Trading a Game of Gambling or Speculation?

It is a real murky distinction between gambling and speculation.

Both definitions arise from games of chance, but perhaps we can make speculation more respectable by stating that ‘speculation requires an enduring edge’…which would make professional poker and blackjack ‘speculative games’ as opposed to ‘gambling games’ such as roulette.

However I think many of us can be confused by how much randomness there is in a liquid financial market and we frequently assign skill to luck. Many are therefore fooled by randomness.

For example here is a series of 30 random equity curves over a trade sample size of 500 trades. Many of the equity curves were profitable with 1 curve providing a 100% return over the trade sample horizon. A large number of traders would assume that over such a ‘large trade sample size’ of 500 trades that a profitable system would have an edge…but this unfortunately is incorrect in this example as every equity curve is compiled from a random sequence of compounded trades.

Now here is the same random series of 30 equity curves with an additional equity curve included (in red) that comes from a system with a long term enduring edge. In this case a trend following system. Notice that the system with an edge plots in the lower range of the distribution of returns. If we applied a selection process that selected the top 10 systems from this array of 31 systems. we would find that the system with the actual edge would be excluded from this selection process leaving us with the top 10 systems which are all random.

We shouldn’t be surprised that all these 10 random systems fail as soon as we take them to the live trading environment. There was no serial correlation in these equity curves which could lead to a ‘causative’ enduring edge.

But now let’s see how the system with an edge plays out over 2000 trades.

Now we can clearly see how the edge plays out over time.

These examples simply illustrate how easy it is to find that someone who believes that they are a speculator actually just turns out to be a gambler ‘in a suit and tie’

Trade well and prosper

The ATS mob